Key Trends in the U.S. Asset-Management Industry: Secular and Cyclical Headwinds

A closer look at the U.S.-based asset management industry’s profitability

Apr 18, 2019

Gregg Warren

Many of the traditional U.S.-based asset managers have benefited
from a bull market in equities for much of the past decade. Concerns
about that bull-market run ending sooner rather than later, though,
have left the shares of most firms in our coverage trading at historic
lows. In addition, ongoing pressures from poor active-equity
investment performance and the growth and acceptance of lower-cost,
index-based products have impacted organic growth and raised
longer-term questions about fee and margin compression.

Historically, we've found that it can often pay to stick with
quality over price during periods of increased market volatility. This
is because firms capable of generating consistent levels of organic
growth and profitability, over a variety of market cycles, tend to
maintain premium valuations to the group. Conversely, those failing in
either regard end up trading at steep discounts.

Below, we explore the anticipated landscape of the asset-management
industry over the next three to five years.

Moving forward, we expect a handful of secular trends to impact
asset managers’ flows, fees, revenue, and profitability. These trends
could potentially limit the asset-management industry’s ability to
generate the kind of outsized returns we’ve seen previously:

An evolving regulatory environment for asset and wealth
managers. Though asset and wealth managers saw little in
the way of additional regulation in the aftermath of the 2008-09
financial crisis, issues of transparency, liquidity,
distribution renumeration, and fiduciary standards have come into
focus.

Retirement phase of U.S. babyboomer
generation. Baby boomers—individuals born between 1946 and
1965—began reaching the U.S. retirement age of 65 in 2011. The
subsequent rise in annual withdrawals and rollovers has put pressure
on flows for defined contribution plans, which had been a strong
source of organic growth for U.S.-based asset managers during the
1990s and early 2000s.

An increased focus on relative and absolute investment
performance and fees. Many investors have become less
willing to pay up when it comes to fees for investment products,
especially when they believe they may not be justified
by performance and investment outcomes.

The ongoing secular shift from active to passive
products. With $3.4 trillion in exchange-traded fund assets
under management at the end of 2018, and another $3.3 trillion in
index-fund AUM, the passive market has become a force with which to
be reckoned. It continues to grow as more investors seek out
lower-cost alternatives to active funds.

Rising costs associated with investment performance and
distribution. Regulatory, structural, and behavioral
changes in the industry have increased the cost of asset management.
Firms are now spending more to help improve performance and enhance
distribution, ultimately squeezing profit margins.

Similarly, we expect several cyclical trends to play a significant
role in asset-management activity:

Curbed U.S. and global economic activity. The
current economic expansion has already gone on longer than most, so
growth can be expected to slow eventually. The U.S. economic
expansion, for its part, is already largely expected to peak in the
next six to 12 months as the effects of the late 2017 tax cuts start
to wane.

End of the post-financial-crisis bull market. The
fourth-quarter 2018 downturn moved U.S. markets closer to ending the
bull market that started after the 2008-09 financial crisis. A
sustained bear market would put further pressure on revenue and
margins, as most asset managers have relied heavily on market gains
to generate AUM growth over the past decade.

Industry consolidation. We expect to see
consolidation, both internally and externally, as asset-management
firms look to increase scale (as a means of minimizing the impact of
fee and margin compression), enhance product offerings, and
eliminate underperforming funds.

With investors focusing on organic growth and profitability when
assessing the U.S.-based asset managers over the past year, we’ve seen
an even wider bifurcation within the group of 12 companies we
cover. This division includes the perceived “haves,” which are capable
of generating organic growth and maintaining margins, and
the “have-nots,” which are expected to struggle to do both or have
fallen into a pattern of poorer performance and positioning.

While the group as a whole is now trading
at price/earnings multiples not seen since the financial crisis,
long-term investors may consider continuing to focus on quality over price.

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